Using an Inappropriate Strategy

It is an easy thing to do, and unfortunately many traders, including experienced ones as well as beginners, make the mistake of using a wrong or inappropriate strategy. They try using an inappropriate strategy to make money trading CFDs. Some even have no strategy at all, and think they can trade by instinct.

The only people who can trade by instinct are those who have been trading for years and paid for their experience many times over. The normal instincts that you possess from life are of no use in the trading environment, and can actually be detrimental to your trading.

‘Plan your trade and trade your plan’ is a common trading maxim, and it is good advice to settle on a trading strategy that you use consistently, and can then refine as necessary. Without a reliable trading strategy that you use on a consistent basis (even a simple moving cross-over system would serve the purpose of a base here), it is almost impossible to find out where your losing trades went wrong, or how to improve your trading. This will usually deliver superior results than a random approach or the use of a constantly switching of trading systems.

Now this may not be news to you. You already understand the need for a trading strategy, and are on your way to forming a winning trading plan. But even then you may find that you are not as successful as you would wish. This can be a case of using an inappropriate strategy.

Firstly, you need to match your strategy to your temperament and your available time for trading. A trading strategy that can work well for a daytrader using one minute charts may not function so effectively if you work all day and place your trades in the evening. It’s true that technical analysis, candlestick patterns, etc. can be applied across all time frames, but you need to adapt the way you use them to suit the market characteristics. Similarly, it would be wrong to use a trading strategy based on monthly charting data if you are looking to trade daily or weekly timeframes.

Some traders tend to believe that a more complex system is better than a simple one. It is tempting to believe that the more complex the trading system, the more likely it is to succeed. This reasoning may be wrong for a couple of reasons. Just because a system has complexity, it doesn’t mean it will follow the markets any better. In fact, some traders develop trading systems that employ huge numbers of data and require very complex computations or go on to produce charts that are so replete with technical indicators that it becomes difficult to see the underlying price action. The systems may be developed and optimized to 10 years of historical data, and may be over optimized because of that. This is known as ‘perfect fit’ optimization, and at some point it is meaningless to try and refine the system anymore. It still will not necessarily perform any better in the future.

The other reason to shun complexity is that you may be more inclined to ignore it or get it wrong during the emotion of trading. While some of the more complex trading systems certainly can be profitable, the more inputs and calculations they require, the more potential there is for something to go wrong. A simple strategy is often the better choice – it can be easily applied and followed, and may well end up to be more reliable than a more complex system.

Another trading strategy which many think is inappropriate or risky is the use of short trades. Being able to short sell an instrument is undeniably a handy utility, because markets do not go up all the time, and if you can take a short position you can profit during the reversals. However, in theory at least, holding a short position is more risky than a long position since your maximum downside on a short position is unlimited. This is so because with a long position in shares, for instance, the worst possible scenario would be for the stock price to fall to zero and become worthless. In contrast, with a short position there is no limit as to how much a stock price could theoretically rise (although in practice your downside is capped by the utilisation of a stop loss order). An advantage of short trades is that prices tend to fall quickly, but only climb slowly, so your profits can be greater. Highly conservative traders might want to take this into account and limit trading on the short side, especially without a stop loss order in place.